August 2024 - THE CIO’S PERSPECTIVE
When Narendra Modi lost control last month of the lower house of the Indian parliament, it was feared that the budget to be voted a few weeks later would be a populist one for the sake of obtaining the support of small coalition parties without which no law, or for that matter no budget, could be passed. This was a risk we flagged last month since populist measures typically translate into higher deficits and into a depreciating currency.
In the end, it did not happen. The budget that got passed was not very different from the previous one, with emphasis once again on infrastructure investments that will represent as much as 23% of total government expenditures and 3.4% of GDP, up from 3.2% last year. Fiscal deficit of the central government is expected to shrink from 5.6% of GDP last fiscal year to 4.9% this year, which in all logic should translate into a slower pace of depreciation of the Indian rupee and a possible upgrade of Indian sovereign debt by rating agencies. The goal is even to lower further the fiscal deficit to 4.5% in next year’s budget. Adding up the deficit of individual states, the consolidated deficit should drop below 8% of GDP, its lowest level since the Covid pandemic.
To cool off the overheated equity market, the government announced that long-term capital gains taxes will rise from 10% to 12.5%, while short-term capital gains taxes will rise from 15% to 20%. Like most observers, we would have expected markets to react negatively to this measure, but that did not happen: Once again, India was the best performing market of Asia in July, the NIFTY index gaining 3.9%.
We remain bullish about India, even though we admit that valuations are high, and corrections can happen at any time. Over the long term, however, the investment case for India remains intact. It is also worth highlighting that the large global asset allocators have very small exposure to that country as it only appeared recently on their radar screens.
In China, the National Bureau of Statistics published its GDP growth numbers for the second quarter. Growth came down from 5.3% YoY in the first quarter to 4.7% YoY in the second quarter, missing the consensus estimate of 5.1% by a rather wide margin. On a QoQ basis, growth came down from 1.5% in Q1 to 0.7% in Q2. To reach the “approximately 5%” growth target set at the beginning of the year, quarterly growth would need to be on average 1.4%. The growth target set for this year is going to be difficult to reach.
Looking into the breakdown of the YoY growth, manufacturing was the locomotive with a 6.2% YoY growth, slightly lower than the 6.4% YoY recorded in the first quarter. Manufacturing was essentially driven by exports, the trade balance of China having expanded by 19% YoY in Q2. The trade surplus reached RMB704bn in June, a historical record that puts China on a collision course with its largest trading partners, the United States and the European Union. Both accuse China of dumping its manufacturing overcapacity on them by taking advantage of a depreciating yuan and by subsidising strategic sectors, a story line that is repeatedly dismissed by Beijing. Both use this story line as a ground for imposing increasingly punitive tariffs that will likely start to bite on the trade surplus which is today the main locomotive of the Chinese economy.
By contrast, the domestic service sector saw growth slowdown from 5.0% in Q1 to 4.2% in Q2, the lowest data point since the Covid reopening. Retail sales growth dropped to 2.0% YoY in June, down from 3.7% YoY a month earlier, the lowest growth rate since December 2022. The property sector also failed to show much of a recovery following the stimulation measures announced in mid-May when the government announced that it was prepared to buy unsold inventory and turn it into social housing. At the current pace of property sales, the stock of unsold inventory ranges from 10 months in Shanghai to 25 months in Beijing and Guangzhou, 35 months in Shenzhen, and is as high as 10 years in many Tier 3 and Tier 4 cities.
It was in this gloomy context that the Third plenum of the CCP was held in July, an event that takes place every five years and that typically lays out the direction of economic policies for the next five years. It was during the Third plenum of 1978 that China’s leader Deng Xiaoping laid out the foundations that saw China move away from the collectivist policies of Mao Zedong and shift towards a capitalist model. Significant hopes had built up for this plenum to deliver a set of guidelines that could have provided the roadmap for future reforms and describe what kind of strategy the Chinese leadership would follow to pull its economy out of the doldrums.
Unfortunately, the Third plenum was a disappointment. No action plan was set, no concrete measure announced, only vague statements were made, leaving markets disappointed. After initially gaining as much as 4% in the run-up to the plenum, the CSI index dropped in the following days and ended the month down 0.5%.
The only concrete reaction to the latest set of downbeat macroeconomic numbers was for Central bank PBoC to cut by 10bps the 7-day Repo rate it applies when lending to commercial banks, down to 1.7%. Commercial banks cut their one-year and five-year loan prime rates by 10bps as well, down to 3.35% and 3.85% respectively. Whether these timid rate cuts will help nationwide credit growth recover remains to be seen. Banks loan growth and private sector credit growth both hit new historical lows of 8.8% and 6.9% YoY in June, down from 9.3% and 7.4% YoY a month earlier.